EM Valuation, Remeasuring Cash Flows with Inflation convert, contrast, appears, why

laurab

So for those of you who have this down, I'm confused of how strict you have to be on the order of a few of the steps. Specifically:

1) It seems like you have to calculate WCInv & taxes from nominal cash flows, and then convert them both to real by using the inflation index for that year. The taxes make sense to me, as you would be paying taxes on nominal CF's in real life, but why must WCInv be calculated from nominal?

2) In contrast, it appears that FCInv must be calculated from real CFs, then converted to nominal to get FCInv nominal. Any reasoning behind this?

I'm referring to pages 111-130 in Schweser Equity and the EOC on pages 299-303 in CFAI Equity book.



Edited 2 time(s). Last edit at Saturday, May 28, 2011 at 10:11AM by ftwcfa.

wxs1986

1) maybe because you want your inventory to be valued at the "inflated"/nominal value rather than the real, lower value? If you want to sell inventory what would you sell it at, the "real" value or the nominal value that some buyer is willing to pay?

2) FCInv is what you spent on equipment; that is a real cash outflow, but then you want to bring it up to nominal terms? Not sure on that one.

ayaz_mahmud369

Ok, I'm going to write-up how I understand this:

There are two tricks to solving for nominal and real FCFs. The first is knowing how to get taxes, WCInv, FCInv, & EBITDA. The second is knowing how to convert these. How to get the four key items:

1) Taxes: Taxes are paid on nominal cash flows (as if the government would let you just pay on real!). EBIT x TR = Nominal Taxes

2) WCInv: Because working capital has things like receivables and payables in it, it is exposed to inflation. Therefore, take nominal NWC (probably given as a % of nominal sales) and calculate the change to get nominal WCInv.

3) FCInv: Since PPE's instrinsic value does not change with inflation, you calculate original FCInv with real PPE. Vignette will probably give you beginning and ending PPE as % of real sales. Real FCInv is just the change in PPE, after adjusting for inflation.

4) EBITDA: real EBITDA is calculated as a % of real sales

Converting them:

1) Nominal taxes are divided by inflation index to get real taxes
2) Nominal WCInv is divided by inflation index to get real WCInv
3) Real FCInv is multiplied by inflation to get nominal FCInv
4) Real EBITDA is multiplied by inflation to get nominal FCInv

Final Note:

Depreciation under both real and nominal is beginning PPE divided by the number of years you are depreciating over. To get next years PPE use the below:

For Real, solve for FCInv:

Beg Real PPE (same for real and nominal)
-Depreciation (Beg PPE divided by # of years depreciated over)
+PLUG: Real FCInv
End Real PPE (Given as % of real sales most likely)

For Nominal, solve for End Nominal PPE

Beg Nominal PPE (same for real and nominal)
-Depreciation (Beg PPE divided by # of years depreciated over)
+Nominal FCInv (Real FCInv x Inflation Index)
End Nominal PPE

In Summary:

You now have EBITDA, Depreciation, and Taxes in both real and nominal terms. You can calculate real and nominal NOPLAT. Once you have NOPLAT, you now have NOPLAT, Depreciation, WCInv, & FCInv in real and nominal terms. You can calculate FCF.



Edited 1 time(s). Last edit at Saturday, May 28, 2011 at 10:42AM by ftwcfa.

firat

thanks for the clarification. could you also clarify the difference between calculating FCinv in a normal FCFF ( change in gross fixed assets) vs the plug in method used in emerging markets as you have described above, im a little shaky in accounting, would appreciate the input.

SFoyil

@mr_moose - they are the same methods. Those accounts up there should say Net PPE, not just PPE. All the net means is that depreciation is taken into account.

Otabek

just one more question! this question might sound dumb but how come we use Real depreciation in the calculation of Nominal EBIT? wouldnt it make sense if we used a nominal depreciation ( depreciation times inflation index)??

DSquaredSlim

I got it. i wish they dont bring this up !

madaochenggong

I am puzzled. On page 119 in Schweser they show a table (Figure 13) for Real vs. Nominal Ratios.
How did they calculate 567 for year 2 Beginning Invested Capital in real terms?

OmarAdnan

I am skipping this topic. so if you guys see this on exam, pray for me.

yospaghetti

^ what he said